Hong Kong introduces detailed transfer pricing legislation

Following detailed consultation last year, the Hong Kong Government has taken decisive action in regard to its efforts to counter tax avoidance through transfer pricing. Specifically, it is introducing detailed and specific transfer pricing legislation for the first time. This is backed-up by a series of associated measures including documentation requirements, country-by-country reporting requirements, and penalty provisions for non-compliance.

It was achieved with the first reading in the Hong Kong Legislative Council of the Inland Revenue (Amendment) No. 6 Bill 2017 on 10 January 2018. The Amendment Bill is expected to be finalised in mid-2018, with Departmental Interpretation Notes and Guidance to follow. Key aspects are set out below:

Key points

  • Implementation– if passed as anticipated, most provisions of the Amendment Bill will come into effect for accounting periods beginning on or after 01 April 2018.
  • Codification of TP rules & definitions– Hong Kong is expected formally to adopt the OECD Guidelines as published on 10 July 2017 (which in broad terms are followed by the Chinese authorities), and the Model Tax Convention of on Income and on Capital as approved by the OECD on 15 July 2014 in determining profits attributable to a permanent establishment of an overseas entity in Hong Kong.
  • What is caught– subject to certain thresholds, the new legislation will catch all transactions or series of transactions entered into by Hong Kong resident persons with associated persons, or intra-entity dealings between a Hong Kong permanent establishment and a non-resident part of the same enterprise. The legislation is intended to cover all kinds of transactions or dealings, and no exemption is granted for domestic transactions. Rules will additionally apply to salary and property tax.
  • Intellectual property– new sections are included whereby any person that has contributed in Hong Kong to the development, enhancement, maintenance, protection, or exploitation (i.e. DEMPE) of intellectual property owned by an overseas associate will be taxed on their value contribution as a trading receipt. This effectively reinforces provisions in the newly revised OECD Guidelines.
  • Mandatory documentation requirements – the Amendment Bill will introduce mandatory requirements for Hong Kong entities that enter into intercompany transactions to prepare and keep local files and master files that are broadly consistent with OECD requirements under BEPS Action 13, subject to certain minimum thresholds.
  • Country-by-country reporting– with effect from 1 January 2018, the new legislation will also require groups with an ultimate parent company resident in Hong Kong to file a country-by-country report if they have consolidated revenues equal to or exceeding €750 million (ca. HK$6.8 billion), again broadly in line with OECD requirements.
  • Burden of proof – if the taxpayer fails to prove in its documentation that intercompany transactions (or dealings with permanent establishments) are consistent with arm's length pricing, then the tax assessor may make an adjustment to taxable income. A statutory dispute resolution mechanism will also be introduced to address cross-border treaty-related disputes.
  • Advance Pricing Agreements (APAs) – the Amendment Bill will codify the APA regime introduced by Hong Kong in March 2012, and extend it to unilateral APAs. The Commissioner will also be given the ability to charge fees based on hourly rates for the IRD officers involved.
  • Penalties – non-compliance with the basic transfer pricing rules will make the taxpayer liable to potential administrative penalties up to the amount of tax undercharged. More severe penalties or sanctions may apply in the most serious cases.

What does this mean?

  • The new legislation clearly represents a marked change in the transfer pricing environment in Hong Kong, and a statement of intent by the authorities. Overall, it seems that the aim is to align practice in Hong Kong with the far tougher stance being adopted around the world.
  • Adoption of the most recent OECD Guidelines and interpretations concerning attribution of profit to permanent establishments potentially signal a shift in how the arm's length principle is applied by the Hong Kong authorities, especially in regard to intangibles and risk, and match the more stringent alignment of value creation with taxation of income as envisaged following the BEPS Project.
  • Tighter documentation requirements will also apply, and it appears that the burden of proof may effectively shift to taxpayers, with stricter penalties likely to follow for non-compliance.
  • Hong Kong taxpayers should review their own affairs to determine how they may be affected by the new legislation, and whether it will give rise to new or greater exposures. Pre-emptive and appropriate action will likely provide protection, but more detailed transfer pricing analysis and documentation will be required, and in-line with how thinking in the field is shifting.

How we can help?

With a combination of in-house, advisory, and tax authority experience, Hogan Lovells has a team of transfer pricing specialists that can help Hong Kong taxpayers in the following ways:
  • identifying whether you have transactions or dealings caught by the new rules;
  • assessing the level of risks and exposures you face, and also highlighting potential opportunities;
  • conducting detailed transfer pricing analyses, and compiling documentation; and
  • providing insights on how Hong Kong and other tax authorities are now approaching transfer pricing.

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